Ultimate Oscillator

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Introduction

Famous market technician, trader and author Larry Williams has many written many popular books on the subject of trading and has created many technical indicators. In his search for the holy grail of trading indicators he discovered that most technical indicators and oscillators typically ran into problems when they were used to analyse market data from different time frames. To overcome this issue, William created what he called the Ultimate Oscillator. The Ultimate Oscillator is an indicator that combines three oscillators which represent short, intermediate, and long term market cycles into one indicator.

Calculation

Williams developed the Ultimate Oscillator based on the idea that buying or selling will determine direction of prices. Buying pressure is measured by where a day's closing price is within the day's true range. The Ultimate Oscillator can gauge the true of strength of a market advance i.e. buying pressure. When buying pressure is strong the Ultimate Oscillator rises and when buying pressure is weak the Ultimate Oscillator falls.

The first step in calculating the Ultimate Oscillator is to calculate what Williams called was Buying Pressure (BP):

BP is calculated to determine the overall direction of prices. Buying pressure is defined as the amount by which the close is above the true low on a given day. The true low is defined as the lesser of the given day's trading low and the previous close.

The second step is to calculate the true range (TR):

 

True range is defined as the difference between the true high and the true low. The true high is defined as the greater of the given day's trading high and the previous close.

The third step is to create averages based on the three timeframes involved (7, 14, and 28):

The fourth step is to create a weighted average of the three averages:

 

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Buy Signal

The Ultimate Oscillator is primarily used to identify divergences to generate buy or sell signals. Buy signals are determined in three steps. The first step is to observe a bullish divergence between the Ultimate Oscillator line and the price action of the stock. For example, in the following chart of Lumber Liquidators we see LL make a lower low in early 2009, while the Ultimate Oscillator forms a higher low. The higher low in the Ultimate Oscillator line is signalling that the downward pressure on prices is losing momentum. The second signal is when the indicator line crosses above the centreline signalling bullish market conditions. The final signal occurs when oscillator line makes a higher high. 

Sell Signal

Sell signals are determined in three steps. The first step is to observe a bearish divergence between the Ultimate Oscillator line and the price action of the stock. For example, in the following chart of Amgen we see AMGN make a higher high May, while the Ultimate Oscillator forms a lower high. The lower high in the Ultimate Oscillator line is signalling that the upward pressure on prices is losing momentum. The second signal is when the indicator line crosses below the centreline signalling bearish market conditions. The final signal occurs when oscillator line makes a new lower high. 

What makes the Ultimate Oscillator unique is how the formula measures momentum for three distinct timeframes. To ensure that each time frame reflects true market cycles William’s formula is designed so that second and third time frame is double that of the first and the second time frame. Williams weighted the averages to reduce the number of false signals that are generated from the oscillator.

Conclusions

Larry Williams designed the Ultimate Oscillator as momentum oscillator that allows traders to use market information from three different timeframes to incorporate market cycle data into the oscillator. By incorporating market cycle data Williams hope to reduce the amount of false signals generated by the indicator. Like many indicators the greatest strength of the Ultimate Oscillator is that allows traders to identify either bullish or bearish divergences. Williams created three simple rules to help traders fine tune buy and sell entries based on Ultimate Oscillator. Williams suggested using the oscillator to identify intermediate to longer term price trends by monitoring crossovers of the centreline. When the oscillator line was above 50, this suggested that longer term market conditions are bullish and when the oscillator line was below 50 the longer term market condition are bearish. By identifying the overall market conditions traders should be able to increase trading success by trading in the direction of the longer term trend. As with all indicators, to improve the odds of success, on should never use the Ultimate Oscillator in isolation. By incorporating multiple technical indicators to confirm trading signals you can increase your odds of trading success and reduce your odds of loses.